Published: Apr 15, 2010

The April 2010 guidelines for short sales and deeds in lieu of foreclosure are geared primarily towards the borrower (seller) and the lender (commonly called a service provider or servicer). However, the guidelines offer benefits to buyers of short sale property, too.

Before I answer your question, I need to provide background information on deeds in lieu of foreclosure, short sales, and government programs meant to stabilize prices of homes and assist distressed homeowners.

If you are a homeowner wishing to sell your home, your first task is to verify the type of loan (mortgage) you have. If you do not know, speak with your mortgage specialist, real estate agent, or an attorney in your state who can review your mortgage contract. If the loan is FHA, VA, Fannie Mac, or Freddie Mac, there are new and different provisions of these guidelines, some of which have not been released as of the date of this answer. If you do not have a FHA, VA, Fannie Mac, or Freddie Mac loan, then the guidelines may apply if your servicer is participating in this program. Most are.

To put the Home Affordable Foreclosure Alternatives Program (HAFA) in context, we need to discuss the two primary alternatives to foreclosure.

Deed in Lieu of Foreclosure at a Glance

In a deed in lieu of foreclosure, the property owner gives the property to the lender voluntarily in exchange for the lender canceling the loan. The item transferred is the deed to the property. The lender promises not to initiate foreclosure proceedings, and to terminate any foreclosure proceedings already underway. The lender may or may not agree to forgive any deficiency balance that results from the sale of the property.

An overlooked downside to deeds in lieu of foreclosure in general is the potential for liability for the deficiency balance. However, under HAFA, participating servicers must forgive the deficiency balance for a deed in lieu of foreclosure.

Under federal law, a creditor is required to file a 1099-C whenever it forgives a loan balance greater than $600. This may create a tax liability for the former property owner because it is considered "income." The Mortgage Forgiveness Debt Relief Act provides tax relief for some loans forgiven in 2007 through 2012.

Short Sale at a Glance

In a short sale, the lender agrees to allow the homeowner to sell the property for less than the balance of the loan. The homeowner’s liability for the deficiency balance is an open question. However, in HAFA, the servicer is prohibited from collecting on a deficiency balance. Unlike a deed in lieu of foreclosure, the ownership of the property is not transferred to the mortgage holder, and remains with the owner until the sale closing.

Some lenders choose short sales (as opposed to deeds in lieu of foreclosure) because they do not want to own the distressed property. They would much rather see the owner, who is motivated to sell the property quickly, handle the details of the sale. Also, lenders make money from lending money and are not well equipped to manage properties.

Whether the servicer picks a deed in lieu of foreclosure or a short sale depends on how the lender balances its risks and how it wants the distressed properties to appear on their books. Local laws may have an impact on the decision, too.

Regarding the homeowner’s credit report, Bills.com readers have reported that short sales have either no or a slightly negative impact on the consumer’s credit score. Fair Isaac & Co., however, reports short sales have a severe negative impact on a homeowners credit score. This is in contrast to a foreclosure, which will have a significant impact on a credit score. If you are facing foreclosure and are given the option of a short sale or deed in lieu of foreclosure, do it! The slight impact a short sale may have on a credit score is no reason to avoid a short sale.

In 2009, the Obama Administration created the Making Home Affordable (MHA) program. An MHA eligibility questionnaire helps homeowners determine if they may qualify. This program has two components: 1) mortgage refinancing through Home Affordable Refinance Program (HARP); and 2) mortgage modification through Home Affordable Modification Program (HAMP). There are provisions that also include homeowners with second mortgages (liens) or even third mortgages. HAMP Borrower FAQs and HAMP Factsheet answer basic questions on the program. The Making Home Affordable Program Web site provides eligibility information, how to request a modification, and additional facts.

HAMP is designed to help homeowners and servicers avoid foreclosure by modifying the terms of the loan to make the mortgage payments affordable for the long-term. The HAMP overview page describes succinctly the requirements that borrowers must meet to be eligible.

The HAMP qualifying criteria include:

Borrower is delinquent on their mortgage or faces imminent risk of default

Property is occupied as borrower's primary residence

Mortgage was originated on or before Jan. 1, 2009 and unpaid principal balance must be no greater than $729,750 for one-unit properties.

HAFA is complex with numerous guidelines set by the Treasury Dept. These new guidelines do not apply to loans by Fannie Mae, Freddie Mac, FHA or VA because these programs have their own short-sale programs that vary from HAFA.

HAFA provides incentives to mortgage lenders (servicers), seller, and other lien holders. There are deadlines that the mortgage lender and subsequent lien holder have to follow to provide timely progression on the sale of the property. HAFA simplifies and streamlines the short sale and deed in lieu process by providing a standard process flow, minimum performance timeframes, and standard documentation.

As mentioned, servicers need not participate in MHA, HAMP, or HAFA, though most do. However, the reality of the deadlines depends on the rigorousness of the servicer to implement the provisions.

The Treasury Dept. picked Freddie Mac to serve as the compliance agent and Fannie Mae as program administrator. The guidelines for payments is still under development by Fannie Mae as this was written.

Regarding credit reports, the servicer still may report to the consumer credit reporting agencies (i.e., Equifax, Experian, and TransUnion) the account as "full file" status. The 45-page document mentioned above contains further details on the credit reporting.

HAFA for Existing Borrowers (Sellers)

Homeowners selling their homes with a deed in lieu of foreclosure or short sale will benefit from a more streamlined process that includes deadlines the servicers must follow, and a $3,000 payment to cover relocation expenses. Also, borrowers must receive disclosures of costs and net proceeds the servicer requires. The HAFA eligibility requirements are the same as the original HAMP.

The bank or financial institution servicing the mortgage (called a "servicer") must respond to a reasonable offer within 10 business days of receipt of all the required documents including the signed purchase offer and Request to Approve a Short-Sale (RASS). The servicer still has the option to reject the offer. However, this timeline will improve the chances of the borrower and purchaser to finalize the sale quickly.

Closing will occur in no less than 45 days, unless all parties agree to a shorter timeline. The most important provision for the borrower is that if the servicer participates in the HAFA program, and the first and second lien holders accept the incentives, then there can be no deficiency judgment. As with any other debt forgiveness, the servicer will issue any deficiency on IRS Form 1099C and may be taxed as income. As mentioned previously, see the Bills.com resource Mortgage Forgiveness Debt Relief Act to learn how to avoid taxes on forgiven mortgage debt.

Quick Tip

Each state legislature created unique foreclosure and anti-deficiency laws. Follow the links just mentioned to learn the foreclosure rules relevant to you.

HAFA for Purchasers (Buyers)

Read the supplement directive mentioned above for the program terms and conditions for purchaser obligations.

For example, the sale and purchase must be an "arms-length" transaction, which means that the buyer and seller must not be related by marriage, family, or commercial enterprise. The buyer also agrees not to sell the property for 90 days after closing. The 10-day time period is a great improvement because it has been common for purchasers to wait months for servicers to review offers.

Recommendations

If you are considering the sale or purchase a property subject to HAFA, check to see if any recent changes to HAMP or HAFA affect you. The official Making Home Affordable and HAMP websites provide current and creditable information.

In sum, servicers are required to respond to offers within 10 business days of receiving all of the buyer's documents and provide specific reasons for denying the offer if it is rejected. This provides the buyer a relatively quick response to offers, and the ability to attempt to negotiate with the servicer. Also, the seller will receive $3,000 to relocate, which will make it possible for financially distressed homeowners to afford replacement housing.

Debt distressing you? The Bills.com Debt Coach is a no-cost online tool that will analyze your debts and show you the options available to resolve them and the costs and benefits of each.

If you have questions about the documents you are signing and what the consequences may be, consult with an attorney in your state who has experience in real property.

Mortgage Principal Reduction | Due to the housing crisis there are many underwater borrowers. A controversial solution is pri...

52 Comments

RecentBest

1500 characters remaining

EB

Dec, 2012

elena

Matthews, NC

Hi Bill,
I would so greatly appreciate it if you could answer my question. I bought an investment property in Aug 2006 for $138,500 and have had it rented out ever since. I did an 80-20 loan with 100% financing. It was built in 1974 and needs a complete makeover inside and out. It has also depreciated in value quite a bit, so I am underwater for sure...by a lot. I know that I need to get rid of it because it is becoming a financial hardship for my family to bear every time the tenants call with a problem. The tenants are on a month-to-month lease at this point. HELP! Short sale? Deed in lieu? Foreclosure? Rent-to-own with the tenants IF (big IF) they qualify? I am greatly worried about this deficiency balance as well as the tax liabilities. I am in Charlotte, NC as is the property. The lender is Bank of America.
Thank you for your help!
Elena

0 Votes

BA

Dec, 2012

Bill

You ask excellent questions. I have six reading assignments to help you understand the issues you face:

Whether you choose a foreclosure, short sale, or deed-in-lieu-of-foreclosure, you will need to deal with the deficiency balance issue. Some states have anti-deficiency laws that prevent the collection of deficiency balances, and other states allow it. Learn your rights and liabilities.

A rent-to-own contract with a tenant has risk, but a well-written contract can help minimize the risks for everyone.

Your potential for tax liability depends on how the lender handles the deficiency balance. Unless Congress and the President extend the Mortgage Forgiveness Debt Relief Act, you may have tax liability if the deficiency balance is forgiven.

After you read each of these articles, I encourage you to ask follow-up questions on the most appropriate page(s).

0 Votes

RK

May, 2012

Robin

Boise, ID

Bill: We are in a similar situation only we can still afford to make the payments, just don't know why we should consider doing so. We pay $11,500 per year interest only and the loan now is adjusting annual until the payments go up to $2400.00 per month. We haven't touched any of the principal in 6 years and don't know if we should continue to make interest only payments on a $184,000 house that is now worth $102,000. We have tried all the options through BOA to get them to change our loan to a fixed rate, they say we can afford the payment and won't work with us. We have stopped making payment but its only been 1 month, are we making mistake? If so, what are our options? Thanks.

0 Votes

BA

May, 2012

Bill

Robyn, by stopping making payments, you're doing great harm to your credit score. Not making payments may or may not influence your lender to modify your loan. I recommend that you speak with a federally approved housing counselor. Call HOPE NOW for a free consultation at 888-995-4673.

0 Votes

EP

Apr, 2012

Erik

Tampa, FL

As of right now I am current on my BOA home loan, I applied for a modification and was denied. I am now starting the short sale process, they told me I could qualify for a HAFA. Times are tough and I am worried I will not make my next payment.

Will missing any payments effect my credit any more or any less in this process?

If i am going to short sale anyway should I be throwing anymore money at anyway?

Do I need a real estate attorney for this process if BOA is willing to forgive the debt already?

You ask a question I cannot answer because in some cases, mortgage servicers require homeowners to be in default before they enter the homeowner in a foreclosure alternatives program. Others have the opposite rule. Ask your servicer what the repercussions are for defaulting on your loan.

Are you 100% certain the servicer will forgive the deficiency balance? By 100% certain, I mean, do you have the promise you mentioned in writing? If yes, then you may be able to accomplish this yourself if you are skilled at reading and understanding contracts. If the servicer has made only spoken promises to you, or you otherwise feel you need an aggressive advocate in your corner, then hire a lawyer.

Yes, a lawyer's time is not cheap, but signing a bad, one-sided deal is very expensive.

0 Votes

TP

Dec, 2011

Tony

Weaver, AL

I filed for disability 6 months ago. My income has drastically dropped and I can not afford the bills and house. Current balance is $94k and last appraisal was $126k. I was approved for a home modification loan and have made the first 2 trial payments, 1 remaining. To be honest even with the modification I won't be able to make ends meet. And now, it appears my marriage will not survive this either. From all I have read here my best option is foreclosure and bankruptcy. Does that sound right?

0 Votes

BA

Jan, 2012

Bill

If you will not be able to pay according to the terms of the loan modification, then you be in default, and face foreclosure.

However, I understand from the information that you provided that your home is worth more than the balance of your loans. If this is the case, then you should seek to sell the property, pay off the loans, and still have money to put in your pocket.

If this is not the case, then your debt relief options will depend on your total debt and asset position. Certainly it is best to avoid foreclosure, if possible, and bankruptcy is an option available in certain circumstances. If you will still owe money after selling the house, then read more about short sales.

0 Votes

AM

Dec, 2011

Alan

Delray Beach, FL

There is a very misleading comment here, to the effect that a short sales doesn't affect your credit scores. That's true, because the effect upon the credit scores has already been effected by the missed mortgage payments. However, while short sale, deed in lieu, and foreclosures don't affect the scores themselves, they have a specific effect upon your ability to get credit, which is that you are barred from obtaining a mortgage for at least two years after each of these events, regardless of your credit scores, and up to four years in the event that the defaults were associated with financial mismanagement. As a loan officer, I deal with this issue all the time....and you won't find this rule in any legislation because the rule is established by lenders themselves and no law pertains to this matter.

0 Votes

BA

Dec, 2011

Bill

Fannie Mae, Freddie Mac, and the FHA publish guidelines that specify the length of time a person must wait after foreclosure and short sale. It is correct there is no legislation, but none is required. It is also true that individual lenders can apply even stricter standards, if they wish.